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David Merkel is an investment professional, and like every investment professional, he makes mistakes. David encourages you to do your own independent "due diligence" on any idea that he talks about, because he could be wrong. Nothing written here, at RealMoney, Wall Street All-Stars, or anywhere else David may write is an invitation to buy or sell any particular security; at most, David is handing out educated guesses as to what the markets may do. David is fond of saying, "The markets always find a new way to make a fool out of you," and so he encourages caution in investing. Risk control wins the game in the long run, not bold moves. Even the best strategies of the past fail, sometimes spectacularly, when you least expect it. David is not immune to that, so please understand that any past success of his will be probably be followed by failures. Also, though David runs Aleph Investments, LLC, this blog is not a part of that business. This blog exists to educate investors, and give something back. It is not intended as advertisement for Aleph Investments; David is not soliciting business through it. When David, or a client of David's has an interest in a security mentioned, full disclosure will be given, as has been past practice for all that David does on the web. Disclosure is the breakfast of champions. Additionally, David may occasionally write about accounting, actuarial, insurance, and tax topics, but nothing written here, at RealMoney, or anywhere else is meant to be formal "advice" in those areas. Consult a reputable professional in those areas to get personal, tailored advice that meets the specialized needs that David can have no knowledge of.

Why Great CEOs Look at their Stock Price Every Now and Then

I was doing my daily reading, when I bumped across the article, Why great CEOs ignore their stock price. Yeah, I know it is the USA Today, so it has to be simplistic. Most of the article is correct. I am not in favor of short-termism, and much less managements managing only to maximize their compensation.

If management/board thinks the price of the stock is undervalued, they will be among those buying shares in the secondary market, improving the value of the shares for the remaining shareholders.

If management/board thinks the price of the stock is overvalued, they may look at other companies to buy that are reasonably priced or cheap that will make their firm more useful. At that point, their stock is a useful currency for acquisitions.

There is a lot of value that can be derived from the current stock price, to a management team that is focused on creating value. Buying back stock when it is cheap, and issuing stock to strategically acquire companies cheaply are important ways of creating value for shareholders.

Part of the job of an investment analyst is to analyze the management team and see if they are managing for themselves or for shareholders. If they don’t use free cash flow well, it is not a good company to own.

One more problem of the USA Today article is that most large investments by corporations tend to do badly, whereas small investments tend to do well. Management teams need to be careful about investing, and ask whether the investments are worth the risk.

Though there are innovative companies that have promising opportunities, such that they do not pay dividends or buy back stock, that’s not true of most corporations — reinvestment opportunities are limited.

It’s wrong to look at a bunch of special companies, and assume that all companies can do the same thing. What I insist from the companies that I own is that they follow portfolio rule six.

Analyze the use of cash flow by management, to avoid companies that invest or buy back their stock when it dilutes value, and purchase those that enhance value through intelligent buybacks and investment.

Not all corporate investment is good. Think of the long-term oriented managements in Japan back in the late ’80s. At that time I thought, “How can accepting low returns on equity be a bright idea?” There is always the possibility of wasting money via overinvestment.

I look for intelligence in the management teams in stocks that I own, and am quick to sell those that destroy value through bad investments, or bad buybacks. I try to think like a businessman in all that I do as an investor. It leads to good results. As Buffett said,

“I am a better investor because I am a businessman, and a better businessman because I am an investor.”

Don’t look for simple metrics to analyze investments. Embrace complexity, and realize that you have to consider how management teams use their free cash, whether to reward investors, or invest for the future, hopefully in productive ways.

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About David Merkel

David J. Merkel, CFA, FSA, is a leading commentator at the excellent investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited David to write for the site, and write he does — on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, and more. His specialty is looking at the interlinkages in the markets in order to understand individual markets better.
David is also presently a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. He also manages the internal profit sharing and charitable endowment monies of the firm.
Prior to joining Hovde in 2003, Merkel managed corporate bonds for Dwight Asset Management. In 1998, he joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life.
His background as a life actuary has given David a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that David will deal with in this blog.
Merkel holds bachelor’s and master’s degrees from Johns Hopkins University. In his spare time, he takes care of his eight children with his wonderful wife Ruth. View all posts by David Merkel →